JC Penney: Better isn’t the same as good

I bought some JC Penney shares on Thursday in advance of their earnings announcement.

I almost never buy individual stocks, but this was an easy decision. Penney’s execution has improved dramatically since Ron Johnson’s departure. Two major competitors–Sears and Kohl’s–are flailing. The year-over-year comparison is absurdly easy. Inventory seems to be tightly managed, which virtually guarantees a solid lift in gross margin. But mostly importantly, negative Wall Street sentiment has been fueled by much fundamental misunderstanding–as evidenced by the large amount of short interest.

My hunch was right. Penney’s reported better than expected performance. And the stock has popped some 15%.

Yet I am keenly aware that better is not the same as good. Penney’s has a huge amount of work to do just to get back to the performance level of the pre-Johnson era which, frankly, was solidly mediocre. The moderate department store sector has basically become a zero sum game where top-line growth must come from stealing share from the competition. And competition is, and will remain, intense.

I am, however, optimistic about the immediate-term. The self-inflicted wounds of the Johnson era are gone. Marketing and merchandising are moving in the right direction. Appropriate attention is now being placed on e-commerce and omni-channel capabilities. As Sears sinks into oblivion, JCP is poised to gain market share and leverage their real estate position. Mike Ullman’s back-to-basics strategy is appropriately conservative and should result in steadily improving gross margins.

It’s also important to note that a year ago Penney’s had done virtually everything one could think of to chase customers away. Importantly, a significant percentage of their stores were off-line in preparation for the home re-launch. Gross margins were getting pummeled by clearance markdowns. Lastly, retail remains a relatively high fixed cost business. As sales improve (both in-store and on-line) Penney’s will start to see tremendous operating leverage.

So for me, better is a virtual certainty for Penney’s–at least for the next few quarters. And those who see the brand at the brink and in need of massive store closings are going to be disappointed (and, as an aside, they also fail to understand the importance of physical stores in driving the online business and overall omni-channel strategy).